Don't Be Fooled by 3G Tech Flukes

Underneath all the phone service providers vying for mobile phone customers with 3G or 4G networks are the companies that are actually building and developing the platforms, and it's important to know who has staying power and who is a flash in the pan, writes Paul McWilliams of Next Inning Technology Report.

Q) As you probably know, Spreadtrum Communications (SPRD) is making a significant amount of noise about their 3G TD SCDMA design wins, while Wall Street is seeing the market as quickly commoditizing. What do you think?

A) Wall Street often falls in love with Chinese-based companies it doesn't understand. That was the case last year when the hype, and what I thought was SPRD over-stating its case, pushed SPRD's price into the $20s.

However, after the price dropped to $14.51, I wrote in an April 30 earnings preview that there was (at the time) room to speculate in SPRD for a "short-term trade," and that I thought there was a good chance for a 30% upside.

Following that, SPRD rallied to a high of $19.75 (a 36% gain) before falling back to trade more recently in the mid-$17s. Hopefully any readers who decided to speculate on SPRD last April exited when it hit my target of $18.86 (the 30% upside).

SPRD built very substantial traction in the feature phone market. competing mostly against MediaTek and, to a lesser extent, against MStar—both Taiwan-based companies. It has since extended its reach into high-end feature phones and has won some (as best as I can tell: not very many) low-end smartphone designs.

As you would expect, SPRD competes mostly on price. However, I don't see their prices as being as competitive as what we're seeing from Marvell Technology Group (MRVL).

MRVL offers complete solutions, including power management, in the $10 to $12 range. MRVL has won the vast majority of real smartphone designs with China Mobile (the only TD-SCDMA carrier), and helped it create the $100 smartphone market. MRVL, which has around 1,000 engineers working in China, has a stated strategy to help push that price point down to $70.

The comment about "quickly commoditizing" is entertaining—MRVL's strategy from day one was to create a commodity market. MRVL is one of the world leaders when it comes to offering very densely integrated solutions at very low (commodity) prices—that is MRVL's core competency and how the company has captured and maintained the market share lead in hard disk drive controllers. MRVL was so good there the hard disk drive companies moved from using captive to its merchant solution (MRVL was able to sell the solution for less than the companies could build it internally).

While I think SPRD will continue to do well in high-end feature phones—which is not a market MRVL directly addresses—and build some design momentum in low-end smartphones, I don't see it as MRVL's primary competitor.

MediaTek is in the process of buying MStar. Together, I think that will be MRVL's toughest near-term competition, and in the longer term, Qualcomm (QCOM) will likely become more of a threat at the low end.

Bottom Line: In my opinion, Wall Street has misunderstood (and evidently still misunderstands) SPRD and where it fits into the equation. Possibly this is one of the reasons why the price of MRVL has been under pressure.

An important thing to keep in mind here is MRVL was very clear that it was maintaining conservative estimates for TD-SCDMA smartphone sales this year—its management was pushed by analysts several times on the call with rumors of higher sales and, in every case, they held to the official estimates provided by China Mobile. In other words, MRVL's forecasts appear to have been couched towards the conservative side of the ledger.